Apropos of the issue of where the Federal Reserve gets the power to "take over" AIG, here's something I find disturbing. As regular readers know, I've been following the housing/credit bubbles since well before it was widely acknowledged that these bubbles existed (though, of course, I was far from the only one to notice). At the height of the bubbles, in 2004-05, there were plenty of people arguing that the Federal Reserve should crack down on the lax mortgage lending practices that led to the current troubles. The Fed's consistent response was, "most of these mortgages are initiated by non-bank mortgage companies, and we only have authority over federally regulated banks, not over mortgage companies."

I assume that that's true. But, in the wake of the current emergency, the Fed has sought and received authority to do all sorts of things it couldn't do before, and has even done things that it's not at all clear it has the statutory authority to do, as with AIG. If only the Fed had been even a fraction as aggressive when the crisis was building!

Much of the blame, of course, lies with Alan Greenspan, who, having served as Fed Chairman during one obvious bubble involving tech, continued to insist during the second obvious bubble (as measured by a comparison to historic housing prices on a variety of measures, as well as the historic laxity of credit standards) that it's impossible to know if wild, unprecedented, asset inflation is the product of a bubble--even though both bubbles had an obvious "Austrian" cause, the Fed's easy money policy, first after the LTCM/Russian bond fiasco in 1998, and then after 9/11.

Greenspan is an odd sort of free market fundamentalist: he used his awesome (government) power at the Fed to artificially lower the cost of credit, but then insisted that the untoward consequences were likely just the natural consequences of the free market at work. Apparently, government intervention in the economy via Fed manipulation of short term interest rates didn't count as "regulation" so long as Alan Greenspan was doing it!

Essentially, the Fed's AIG action was either extra-legal or it was legal, but only through a stretching of its powers. And by nature, those sorts of things have to be justified based on "desperate times for desperate measures". So you can only do them when you have a total emergency.

A War on Terror analogy. After 9/11, the Bush Administration did a bunch of stuff that many contend was either illegal or legal only through a big stretch of executive powers.

Now, does it therefore make sense to say that the Bush Administration was responsible for 9/11, because if it had exercised those emergency powers upon first taking office, they would have discovered the plot? I don't think so. You can't exercise this sort of power until the emergency actually happens. That's the nature of extraordinary power claims.

The Court has never been as active as they should be in keeping the President and Congress bound by their Constitutional chains. They're generally much quicker to strike down something at the state level than anything either of the other two branches of the Federal government are doing.

David, the Federal Reserve has at all times in the last week acted consistent with its authority under the Federal Reserve Act.

Now, the extent to which one A.Greenspan should be blamed for not doing more with his existing authorities and for not seeking (along with the FDIC and SEC) additional authorities to do more to stop the asset bubble from growing so large can be legitimately debated.

frex, credit default swaps are, essentially, an insurance product. Did anybody step up and require that the purchasers be insurers?

The legal form of a mortgage pool is a trust. Did anyone step up and demand that the trustee (the IB) live up to its fiduciary duty? Like doing adequate due diligence on the pooled loans / having an arms length relationship with the rating agency / ensuring that the loans in the pool were sufficiently diverse?

No, no, no.

[yes, the democrats are to blame also. satisfied? but the bulk of the responsibility for this mess lies directly at the feet of the executive branch and a deregulate-at-all-cost mentality.]

The Fed's consistent response was, "most of these mortgages are initiated by non-bank mortgage companies, and we only have authority over federally regulated banks, not over mortgage companies."

I believe that is precisely accurate. The Fed can only regulate commercial banks with a Federal charter. Investment banks, state-chartered banks, mortgage companies and hedge funds all contributed to what's happened, and none are subject to Federal Reserve control or oversight. In addition, many (most?) of the mortgage based derivative trading instruments didn't even exist at the time the current Federal Reserve regulations were structured. In fact, many of the traded derivatives were not even secured by a lien on real estate, but were representative of the interest payments only, almost like a futures contract on mortgage profits. When the mortgage-based securities began to lose money, some of the derivatives became valueless - as opposed to mortgages, which even in default, have some residual value in the real estate collateral. The housing bubble collapse started this, but the reason for such as Lehman and Merrill Lynch is the complete loss of investment in the over-leveraged derivatives.

While all this was happening, Congress was working at cross purposes, pushing for higher risk rated mortgages and loose money supplies. Google Barney Frank and Fannie Mae, Countrywide Mortgage, etc.

it's hard to see how the Federal Reserve could have controlled any of this, although the too-low interest rates certainly accelerated the process at the least.

"he used his awesome (government) power at the Fed to artificially lower the cost of credit, but then insisted that the untoward consequences were likely just the natural consequences of the free market at work."

So true. Classic Greenspan, to the degree anyone really understood what he was saying.

I don't often agree with you, but we're on the same page on this one. Some proactive regulation here would have gone a long way. On your last point, though, I'm not sure the "regulation" was considered "free market" solely because Alan Greenspan inspires confidence and awe, but more out of a gut feeling that regulation that increases profitability in the short term is not regulation in the same way as regulation that decreases short term profitability.

It's worth keeping in mind that the United States Federal Reserve was created following the recommendation of the National Monetary Commission. The NMC was set up in the aftermath of the Panic of 1907 to analyze the failure of U.S. government policy to stem the liquidity crisis that hit the banking system and led to a severe recession.

In other words, the first order of the Federal Reserve -- and of central banks in general -- is to command all hands on deck to stop a financial crisis. 101 years later, it's a good thing that we have a Fed that remembers why it exists in the first place.

Letting AIG fail would be the equivalent of letting the Bank of the United States fail in 1930 which, as Milton Friedman pointed out, was a fateful decision on the part of the Fed.

"even though both bubbles had an obvious "Austrian" cause, the Fed's easy money policy, first after the LTCM/Russian bond fiasco in 1998, and then after 9/11."

Surely you jest. I'm glad it's "obvious" to you that the low interest rates were the "cause" of the housing bubble, because it's not obvious to the vast majority of economists. Where does the complete abandonment of lending standards play into your little story?

Was the low fed funds rate a contributing factor in the housing bubble? No doubt. Was it the "obvious ... cause" of the housing bubble? Only to the most committed ideologues.

There's a reason Austrian economics is considered a fringe school of economics that's populated mostly by crackpots and conspiracy theorists. Believe it or not, the money supply isn't the cause of every problem. The world just ain't that simple.

There's a reason Austrian economics is considered a fringe school of economics that's populated mostly by crackpots and conspiracy theorists. Believe it or not, the money supply isn't the cause of every problem. The world just ain't that simple.

Well, I happen to consider the Austrians crackpots myself, and I don't consider the money supply to be the cause of every problem. But do you really think that the current crisis would be nearly as serious if the Fed hadn't rescued investors from enough previous ones to convince them that they could safely invest in yet another bubble-inflated asset? Greenspan may have been an expert firefighter, but he left the woods so full of dry brush that the next blaze was bound to be uncontrollable.

The questions above asking which new thing 'we' should switch to is begging the question.

Quite frankly I don't care if they start handing out free money machines to voters left and right and completely obliterate the dollar.

Just stop forcing me to use it. Alternate currencies can easily prove or disprove the value of gold, austrian economics, infinite wealth, or whatever theory one ascribes to. However it's currently illegal to operate any currency in the USA that competes with federal reserve notes, and doing so will result in men with guns from the government attacking such operations.

One very short bill called the 'Competition in Currency Act' has been introduced in Congress that simply removes the illegality of competing currencies. From there people are free to do the wise or stupid things they wish to do, almost certainly defaulting to the US Dollar when in doubt.

If we know that thinks like tech in the '90s and housing in the '00s are bubbles, and we play along anyway, why are we trying to assign blame to Greenspan or any of these politicians?
We're alcoholics who hang out in bars, near I can tell.

The Federal Reserve has powers which go beyond merely regulating member banks. For example the Federal Reserve Board's Regulation T (credit by brokers and dealers section 220) operates under the authority of the SEC act of 1934 (U.S.C.78a et seq) and among other things can set margin rates. The Fed should have set the margin rate much higher to discourage excessive leverage. Of course the clever guys can get around these regs using derivatives. I don't know if the Fed can regulate the use of derivatives but it should have. We need a securities lawyer for this one.

There's a reason Austrian economics is considered a fringe school of economics that's populated mostly by crackpots and conspiracy theorists. Believe it or not, the money supply isn't the cause of every problem. The world just ain't that simple."

I too believe the world "isn't that simple" but it would be a hell of a lot simpler if we had currency that couldn't be created out of thin air! Austrian economists simply believe in free markets and sound money. If you think that's "crackpot" then please enlighten me as to your superior economics.

I believe that sound money is a human rights issue. Zimbabwe being a case in point. If you don't get this right everything else goes wrong with it. Of course there a lot more to life than material objects and wealth but, where wealth is concerned, I believe that inflation via fractional banking and fiat currency is insidious and harmful. It works as a regressive tax.